In the past 12 months, claim statistics show that there has been a significant increase in both the number of claims made and HMRC scrutiny of those claims. As a result of this, existing claimants for software R&D projects should be aware that certain areas are now likely to be examined more closely.
Following on from the 5th October 2018 update to the HMRC CIRD manual with updated guidance given on software claims in R&D tax relief: conditions to be satisfied: BIS Guidelines (formerly DTI Guidelines) (2004) – application to software , at the end of 2018 HMRC released CIRD81980 which gives 4 fictitious software R&D claims case studies.
We set out some of the key points in the case studies in terms of how this affects R&D claims for software projects and begin by noting that there are a number of interesting features of the case studies chosen.
Firstly, all four are in respect of claims that contain qualifying R&D projects that meet the criteria of seeking a technological advance through the resolution of technological uncertainty. In each case, different boundary aspects have been highlighted. These boundary areas are frequently the most difficult to ascertain, verify, and explain to HMRC in any claim.
Specifically, these are:
- Differentiating between the commercial project and the R&D project for tax purposes
- Determining when the R&D project for tax purposes starts and ends
- Differentiating between the parts of the R&D project that are allowable (i.e. those that directly contribute to the resolution of technological uncertainty) and the parts of the R&D project that are not allowable (almost anything else).
While there may be concern that projects that specifically match the areas within the case studies (data and IT services cloud migration, big data analytics, machine learning, UI/UX experience and computer vision) will be subject to a more simplistic scrutiny by HMRC staff who try to compare the technical information provided with a claim to the case studies, we believe that this is unlikely to occur if the project qualifies and where the basis for eligibility is well explained in the supporting claim documentation. Where the basis for eligibility is not clear, then closer inspection could result in rejection of some or all of the claim.
As well as explaining why an R&D project is eligible (i.e. attempting a technological advance in terms of industry capability through the resolution of technological uncertainty) the three boundary areas highlighted above must be adequately explained. Although we cover them during the technical interviews, given the increased HMRC focus in these areas, this will receive an increased emphasis.
The first, and most important question, is whether there is an eligible R&D project considering the knowledge of the IT industry as a whole. ‘We haven’t done it before so it must be R&D’ is not correct.
Once qualifying R&D is ascertained, there also needs to be a clear differentiation between the commercial project and the R&D project. As the BIS Guidelines make clear, there is no 1:1 mapping between the two and there may be one or more R&D projects (that may themselves be comprised of sub-projects) that are elements of a single wider commercial project, or conversely, a commercial project may form only a part of an R&D project.
In either case, the boundaries of the R&D project are formed by the presence of technological uncertainty (again, baselined against the industry as a whole) which determine when the project starts, when the project ends, and what can be included in the claim.
Finally, simply assuming that an employee was working 75% of the time on “development” and then claiming 75% of their salary will not withstand scrutiny unless it can be shown that it was qualifying development for tax purposes and that the percentage of the costs claimed was the proportion of time directly contributing to the resolution of technological uncertainty. The mapping of the technical eligibility to the qualifying costs and explaining clearly to HMRC how this has been done is therefore the key element here.
It is worth a further comment on where these case studies have come from. With more than 100 clients, we still have a virtually zero rate of enquiry and a 100% claim success rate. However, even we have had one referral of the technical elements of the claim by the HMRC compliance officer in the R&D unit to the HMRC CTO unit who act as in-house IT consultants and who may disagree with the technical staff involved in the claim preparation, for example, as to whether something was ‘readily deducible’ (as a side note, we prepared our client’s technical staff thoroughly and together successfully argued the validity of the entire claim). The style of these published case studies, while fictitious, is extremely similar to the actual reports produced by the CTO office which provide an opportunity for HMRC’s own IT staff to give an opinion on the technical validity of the work.
We believe that it is only a matter of time until HMRC begin to target all claims of a particular type that have been submitted using their own statistics to identify claims prepared where eligibility is suspect, boundaries between qualifying and non-qualifying work are not drawn correctly and where the costs claimed do not match the technical work carried out.
While this ‘weeding out’ process of ineligible and badly prepared claims is on-the-whole good news for genuine R&D performers, we would be unsurprised to see more news of increased enquiries and challenges, especially in the software sector.
 With the exception of Qualifying Indirect Activities which are outside the scope of discussion here